The Government of Romania (hereinafter, Romania, or the country) has been assigned the following ratings under the international scale:
- Long-term foreign currency credit rating at BBB and local currency credit rating at BBB;
- Short-term foreign currency rating at S2 and local currency credit rating at S2.
The outlook on the long-term foreign currency credit rating is Stable and local currency credit rating is Stable.
The Stable outlook assumes that the rating will most likely stay unchanged within the 12 to 18–month horizon.
Credit rating rationale
Romania’s BBB sovereign credit ratings are supported by the country’s low level of public debt, strong economic growth and diminished external debt of the economy. The ratings are constrained by the unsustainability of economic growth in the medium and long term, low efficiency of monetary policy, growing rigidity of budget expenditures, and low external debt coverage. Weak institutions is also a constraining factor.
Romania’s GDP growth has been robust in recent years. Since 2016, it has averaged 5.3%, the third highest in the EU. However, the growth rate is likely to slow. ACRA expects GDP growth to be around 4% in 2019 and further ease to close to 3.5% in 2020. This moderation is due to significant challenges to supporting the existing level of wage growth, which is a primary contributor to the country’s economic growth. The expansion of wages was previously driven by one-off administrative measures that provided for a strong increase in public sector wages and the minimum wage, which has almost doubled since 2016. In ACRA’s view, going forward the sustainability of the current wage growth dynamics is questionable without a significant improvement in productivity.
Another constraint is a potential reversal of investors’ sentiments toward financing Romania’s “twin deficits” of the general government and the current account, which should eventually affect economic growth. Finally, Romania is likely to be impacted by an economic slowdown in its major EU trade partners, though to a lesser extent than its Central Eastern European (CEE) peers given the smaller international trade volumes in the economy. In the long term, Romania’s growth potential is likely to be constrained by poor demographics coupled with a high emigration rate and the low innovative capacity of the economy. While in the near term ACRA does not foresee a risk of a substantial loss of competitiveness resulting from high wage growth due to a low share of compensation of employees on gross value added and low nominal labor costs, in the long term, the economy has to boost its innovative potential in order to sustain higher wage growth.
Low effectiveness of monetary policy has been demonstrated by the significant challenge that the National Bank of Romania (NBR) faces in keeping inflation within the target range, which has only been achieved twice since 2008 based on Eurostat’s average annual HICP inflation. The NBR’s slow progress in tightening its policy, taking into account inflation overshooting and strong economic growth coupled with the positive output gap, poses a question about the adequacy of monetary policy.
Romanian public debt, which stood at 35% of GDP by the end of 2018, is relatively low by the EU standards. ACRA expects public debt to be around 36% by the end of 2019 and 37.5% by the end of 2020. The decline in the debt-to-GDP ratio since its 2014 peak of around 39% of GDP can be attributed mainly to very strong nominal GDP growth. This disguises the worsening of the primary balance, whose deficit widened to 1.8% of GDP in 2018, with the headline budget deficit amounting to 3.0%, the second worst in the EU. ACRA expects the headline budget deficit to further widen to 3.5% in 2019 due to recent legislative changes mandating increases in public sector wages and pensions, moves which strengthen the pro-cyclical pattern of fiscal policy that has already contributed to the emergence of a twin deficit and positive output gap. These measures coupled with a moderating GDP growth rate will push public debt up and contribute to the inflexibility of the expenditure side of the budget in the near future. In ACRA’s view, the enforcement of Romania’s fiscal rules is weak and the rules are poorly respected.
In 2018, wages, social transfers and interest payments made up 74% of total revenues, up from around 60% in 2014–2015. In the long term, the debt sustainability will be challenged by increasing aging-related costs. According to the European Commission, Romania faces an increase in pensions, healthcare and long-term care costs amounting to approximately 3% of GDP by 2060. This means that in the long term, Romania will have to undergo a fiscal adjustment of 5.9% of GDP in order to stabilize its debt-to-GDP ratio, which is the second highest in the EU. The share of public debt held by non-residents and denominated in FX is close to 50%, with the FX component only slightly below international reserves. Only 100% coverage is mitigated by the long-term debt profile.
The risk of contingent liabilities related to the financial sector is contained. Moderate euroization and banks’ relatively high exposure to domestic government bonds are mitigated by strong banking sector metrics and low private sector debt. The absence of any recent bank bailouts is also a risk-mitigating factor.
Risks associated with the country’s external position are moderate. External debt to GDP has been declining since its peak of 77.5% of GDP in Q2 2011 to 50% in Q2 2018 thanks mainly to robust GDP growth and stagnating external debt. However, the structure and coverage of external debt is a concern. In Q2 2019, the share of FX debt in external debt stood at 85%, making it the third highest among the non-Eurozone EU CEE countries, whereas the reserve coverage of FX debt was at low 41%. The country’s international reserves only covered 80% of the external debt maturing in 12 months starting from Q2 2019. The latter, though, is somewhat mitigated by the breakdown of external debt by sectors. Only 30% of external debt is held by banks and private non-financial sector companies, which are prone to refinancing, whilst more stable sectors like corporates with their intercompany lending and general government accounted for 30% and 40%, respectively.
The current account (CA) deficit, which stood at 4.6% in 2018, is expected to widen to 5% in 2019, driven mostly by domestic consumption. The increasing CA deficit coupled with economic growth moderation could trigger depreciation of the local currency, which has recorded the second weakest performance against the euro among the EU CEE currencies this decade. Potential currency depreciation, which may materialize in the conditions of a severe financial crisis or further widening of the twin deficit, could make the government and others sectors’ debt burden heavier due to the high portion of FX debt in the total indebtedness and its insufficient coverage.
The average score for Romania’s Worldwide Governance Indicators is only slightly above the global average and is the worst in the EU. Romania is lagging behind, especially in the Government Effectiveness and Control of Corruption categories, which could imply misallocation of resources in the economy with a potentially negative impact on economic growth. Political stability, for which Romania has the second worst score among the EU countries, is constrained by frequent changes of government and a strongly divided electorate resulting in large-scale protests against corruption and abuses of power.
Sovereign model application results
Romania has been assigned an A- Indicative credit rating in accordance with the core part of ACRA’s sovereign model. A number of modifiers in the modifiers part of the model allow the Indicative credit rating to be decreased. These include the following, which are determined by the Methodology for Credit Rating Assignment to Sovereign Entities under the International Scale:
- Potential economic growth;
- Sustainability of economic growth;
- Efficacy of structural, economic and monetary policies;
- Market access and sources of funding;
- Debt sustainability;
- Fiscal policy framework and fiscal flexibility;
- External debt sustainability.
In view of the abovementioned modifiers, Romania’s Indicative credit rating has been reduced by two notches. A Final credit rating of BBB has been assigned. There are no extraordinary factors that could result in an adjustment of the Final rating. In connection with this, the Assigned credit rating remains at BBB.
Potential rating upgrade factors
- Improvement in institutional factors;
- Combination of strong economic growth and prudent fiscal policy;
- Diminishing exposure to FX risk in the economy, including the public sector.
Potential rating downgrade factors
- Further deterioration of the long-term debt sustainability;
- Significant drop of economic growth rates with sustained twin deficit of fiscal and current account balances;
- Substantial decline of reserve coverage ratios, especially for the external FX debt.
Issue ratings
No outstanding issues have been rated.
Regulatory disclosure
The sovereign credit ratings have been assigned to Romania under the international scale based on the Methodology for Credit Rating Assignment to Sovereign Entities under the International Scale and the Key Concepts Used by the Analytical Credit Rating Agency Within the Scope of Its Rating Activities.
The sovereign credit ratings have been assigned to Romania for the first time. The sovereign credit ratings and their outlook are expected to be revised within 182 days following the publication date of this press release as per the Calendar of planned sovereign credit rating revisions and publications.
The sovereign credit ratings are based on information from publicly available sources, as well as ACRA’s own databases. The sovereign credit ratings are unsolicited. The Government of Romania did not participate in the credit rating assignment.
ACRA provided no additional services to the Government of Romania. No conflicts of interest were discovered in the course of the sovereign credit rating assignment.
